Monday, Dec 10 2012
• 10 a.m. (ET)

The Mortgage Interest Deduction And The U.S. Housing Market

President Barack Obama seems to be, so far, holding firm on his campaign pledge to raise tax rates for those with taxable income above $250,000, but he has also not ruled out reducing or eliminating longstanding tax breaks including the mortgage interest deduction. It’s been in effect for almost a century, and now costs about $100 billion a year in lost tax revenues. For many upper income tax payers, its benefit is clear, and it’s also believed to encourage home ownership. Please join us to discuss who the mortgage interest deduction helps, who it hurts and what would change if the rules were modified.

Guests

Eric Toder
fellow at the Urban Institute and co-director of the Urban-Brookings Tax Policy Center.

Lawrence Yun
chief economist of the National Association of Realtors.

Seth Hanlon
director of fiscal reform at the Center for American Progress.

Ed Pinto
resident fellow at the American Enterprise Institute and former executive vice president and chief credit officer for Fannie Mae.

Transcript

10:06:56

MS. DIANE REHMThanks for joining us. I'm Diane Rehm. The mortgage interest deduction is just one of the bargaining chips in play as President Obama and House Republicans debate ways to avert this so-called fiscal cliff. But it's a tax perk many homeowners and the overall housing industry have long enjoyed. Here to talk about what would change if the mortgage interest deduction were to be modified or eliminated: Seth Hanlon of the Center for American Progress, Eric Toder of the Urban-Brookings Tax Policy Center and Lawrence Yun of the National Association of Realtors.

10:07:41

MS. DIANE REHMI know many of you are interested in this question. I hope you'll join us, 800-433-8850. Send us an email to drshow@wamu.org. Follow us on Facebook or Twitter. Good morning to all of you.

10:08:01

MR. SETH HANLONGood morning.

10:08:02

MR. ERIC TODERGood morning.

10:08:02

MR. LAWRENCE YUNGood morning.

10:08:03

REHMEric Toder, I'd like to start with you. Give us quick overview of the mortgage interest deduction. Who does it benefit the most and how much is it costing?

10:08:18

TODERWell, the mortgage interest deduction, generally, businesses can deduct interest when they invest in an asset because it's used to produce income, to get at their net income. But people who were investing in assets that don't produce income cannot deduct the interest, and allowing them to basically subsidize those assets reduces the cost of it.

10:08:38

TODERThe mortgage interest is estimated by the government to cost about $1.3 trillion over the next 10 years. That is assuming that the Bush tax cuts expire. If they didn't expire and rates were lower, they would cost about $1 trillion. The biggest beneficiary of these provisions are upper-middle income taxpayers, taxpayers in the top fifth of the distribution, but not the top 1 percent. That is people whose incomes are between around $100,000 and $500,000.

10:09:15

REHMSo how much would their houses cost? Is there any way to measure that?

10:09:23

TODERWell, it's quite variable. I mean obviously, people in that bracket are buying houses at different levels of cost depending on where they live, and they're deducting different amount of interests depending on how long they've owned the house and their age and so forth. But, you know, were talking about -- the biggest beneficiaries are people who live in metropolitan areas with high housing costs: New York, Washington, D.C., L.A., Chicago and so forth.

10:09:58

REHMSeth Hanlon, how does this compare to other tax deductions, other tax receipts?

10:10:09

HANLONRight. So of the list of all the so-called tax expenditures, all of the tax deductions and credits, exceptions, the mortgage interest deduction is the third biggest.

10:10:21

REHMThird biggest. OK.

10:10:21

HANLONIt's the third biggest, yes. It's one of the three biggest. The first is the exclusion for employer-provided health care insurance. And then the second is the combined effect of all the retirement savings provisions, and that costs about $160 billion per year. And then the mortgage interest deduction comes in at about $100 billion per year.

10:10:43

REHMAnd what about charitable deductions, for example?

10:10:50

HANLONIt's less than that. I think the charitable deduction is about 40 or $50 billion a year, so that -- all of these are within the top 10 biggest tax brakes.

10:10:56

REHMAll right. And, Lawrence, you and your organization has certainly been among the most vocal and speaking up against making changes to this deduction. Tell us some of the reasons why.

10:11:15

YUNWell, we are here to represent the property owners of America, and 75 million homeowners will be impacted by changes in mortgage interest deduction because mortgage interest deduction is very unique in terms of tax expenditure. Economists call something called capitalization. The way to think about it as there's an asset that pays dividends for homeowners. If that dividend no longer flows and whether it goes to the government, then that asset value will naturally decline.

10:11:48

YUNSo the total elimination of mortgage interest deduction in our calculation is about 15 percent price reduction in the country. So even a homeowner, who may not have any mortgage -- they have already paid off their mortgage, someone already retired -- they may see a 15 percent price decline, and that's a substantial hit to the early retirement income. There's a substantial hit for families who want to put their kids to college. So for these reasons, we are very opposed to the changes in mortgage interest.

10:12:20

REHMYou're saying if homeowners who own their own homes and who are not taking that tax deduction because they have no mortgage, if they then try to sell their homes, they're going to take something like a 15 percent hit on the cost of that home if the mortgage deduction is phased out.

10:12:47

YUNThat's right. It even makes it much less attractive for home buyers to consider buying a home. They would run through the calculator and say, you know, what price would I be willing to pay without the mortgage interest deduction? And through their calculation -- I mean, you can have, say, two same homes side by side, one with taking mortgage interest deduction, one that is paid clear, so no mortgages. But when it's time to sell their home on the market, you will be priced the same, independent of the homeowner situation regarding their tax benefits.

10:13:21

REHMAnd if that mortgage rate deduction were taken away, how would it affect the real estate industry itself?

10:13:32

YUNWell, it will certainly slow the home sales activity, and I would say it's possibly the worst possible timing to be thinking about removing mortgage interest deduction because, as everyone knows, it's been five years of grueling housing market downturn. And now, finally this year, it's showing some signs of life. It's a recovery but a fragile recovery.

10:13:56

YUNAnd if we stop the recovery process, then one can say that people who are marginally underwater who may be looking forward to possibly coming above water next year, well, that will not happen because it will have a negative impact to prices, foreclosures will be rising. And also, some of the economic contribution, GDP growth that has been -- as a result of housing market recovery, that will come to a halt, so the timing is quite bad at the moment.

10:14:24

REHMLawrence Yun, he is chief economist with the National Association of Realtors. Join us, 800-433-8850. Seth, I gather the Center for American Progress has a plan to phase out this deduction. First, talk about why you think this is the right move at the right time.

10:14:54

HANLONSure. Well, first, to respond to something Lawrence said, I think - I believe the numbers that Lawrence is talking about refer to a complete elimination of the mortgage interest deduction, which is not -- that's not what in our plan, and it's also highly doubtful that Congress would do something like that. I think more intermediate steps like limiting some of the cost of the deduction and targeting it better are more likely. And that's more like what we would like to see.

10:15:21

REHMTargeting how?

10:15:23

HANLONSo right now, the deduction is supposed to be a subsidy for -- an incentive for homeownership. But it's -- as Eric mentioned, it happens to be skewed towards high-income people who tend to be the type of people who might own a home to begin with or be able to afford a home even without this extra incentive. So it's -- because it's a deduction, it provides the biggest benefits to people in high tax brackets.

10:15:51

HANLONAnd so it's sort of a poorly designed, poorly targeted subsidy if its purpose is to expand the pool of people who are going to become homeowners. So our plan takes a look at the deduction, and we don't eliminate it entirely. And we definitely don't do it all of a sudden. So we do two things. We transform the deduction into a credit that is worth a flat amount. So if you -- let's say you have $1,000 of mortgage interest. With the deduction, the savings to you depends on your tax bracket.

10:16:24

HANLONAnd the higher your tax bracket, the more you're going to save. And we think that's inefficient and also a little unfair. With a credit, if you have $1,000 of mortgage interest and we have an 18 percent credit in our plan, you're going to get $180 no matter -- of savings directly no matter what your tax bracket is. So it's just better targeted at people of all tax brackets. And then the second point is we don't do this immediately, our plan. It's phased in over a period of 10 years.

10:16:55

HANLONAnd that's to address I think, you know, some of the concerns that Lawrence has raised about the state of the housing markets and the effect on prices and also just people's expectations when they're buying a home and expect to have -- to be able to write off some of their mortgage interest at the beginning of the mortgage. So we think it's a, you know, it's a balance between making the deduction less costly to the government contributing to the deficit reduction, but -- while also, you know, protecting homeowners.

10:17:26

REHMAnd this is something that was done in England a while back. How did that go?

10:17:33

HANLONRight. So in England, England basically phased down and then phased out its mortgage interest deduction over a period. They had one similar to ours, and they phased it out over a period of about 20 years. And -- but if you look at the statistics, you know, over time, there was no -- I believe, homeownership in England grew at about the same rate, maybe even higher than in the United States. I'm not saying this is the only factor, but it certainly was no barrier or, you know, didn't destroy homeownership in England.

10:18:05

REHMAnd how much support do you think there might be in the Congress or at the White House?

10:18:13

HANLONWell, I think they're, you know, they're looking at that now. So they're looking at really sort of across-the-board type solutions for tax benefits. There are some interest on the Republican side and a dollar cap on all tax breaks. And I think they see -- the advantage of that is that it's not, you know, focused on any one tax break. So we'll see. It'll be talked a lot next year.

10:18:37

REHMSeth Hanlon, director of fiscal reform at the Center for American Progress. After a short break, we'll talk more, take your calls. I look forward to speaking with you.

10:20:06

REHMAnd joining us now by phone from Las Vegas, Ed Pinto. He is with the American Enterprise Institute. He's former executive vice president and chief credit officer for Fannie Mae. Good morning to you, sir.

10:20:25

MR. ED PINTOGood morning, Diane. Pleasure to be on the show.

10:20:26

REHMThank you. Ed, you say you think we ought to eliminate this tax deduction altogether and now is the perfect time to tell -- to do it. Tell us why.

10:20:40

PINTOI think the interest deduction on homes ends up distorting the market. It's the same reason that England decided to get rid of it 30 years ago. So I don't believe it should be done all at once. I think one or two things should be done, either phase it out, much like was described by the earlier individual talking about England, phasing it out over 20 years perhaps. Alternatively, I think having categories -- a limit on the categories of deductions and overall dollar limit is also a good idea for the same reason.

10:21:14

PINTOI don't believe the idea of a tax credit is a good one. The -- A, it's going to distort housing once again, and we've been distorting housing all too much, particularly homeownership. But secondly, the standard deduction, which today is, I believe, around $12,000 -- and you get that without having to document any deductions -- already covers the lion's share of any interest that these individuals would've had. It's already there to cover that.

10:21:44

PINTOAnd lastly, the -- in terms of doing it today and the comment about people relying on the interest deduction, when interest rates are very tremendously -- just three or four years ago -- five years ago, interest rates are 6 percent. Today, they're 3.5. A lot of people have refinanced. The tax deduction is less than the difference between, you know, the 6 percent and the 3.5. The government is pushing down rates. It certainly can change the policy on deductions over time.

10:22:14

REHMSo you heard Lawrence Yun say that without the mortgage interest deduction, home prices could go down. What do you think of that?

10:22:29

PINTOAgain, I think if it were done all at -- in one time in terms of eliminating interest deduction, it would have some impact. I don't know if 15 percent is the right number or not. I'm not suggesting it be done all at once. I believe that if it's done over a period of years, just the deduction itself phasing it out, it would have minimal impact. And if it's done as part of an overall cap on deductions, again, it would have minimal impact because it just wouldn't all hit at one time.

10:23:01

REHMYou know, it's interesting because this mortgage interest deduction has been in place for such a long time to encourage people to be part of homeownership, somehow, as part of what this country is all about. Do you think that's changing?

10:23:28

PINTOI think what's changing -- and I have a report that's coming out later this week that talks about this -- is that in order to get individuals in working-class neighborhoods, which is what people are always talking about, how you get homeownership to people with, you know, lower incomes -- we haven't done a very successful job of doing that in a way that is responsible. The foreclosure rates, the delinquency rates, the impact on neighborhoods has just been horrific.

10:23:59

PINTOAnd that continues today. And I'll be outlining that later this week how FHA lending today really negatively impacts working-class neighborhoods -- very specific working-class neighborhoods around the country in ways that are very detrimental. And it's because the lending that FHA is doing, the insurance of these loans is not being done responsibly.

10:24:23

REHMHmm. Eric Toder, do you want to comment?

10:24:26

TODERWell, just one comment on, I think, the myth that the mortgage interest deduction was put in as a deliberate policy to support homeownership. Actually, interest was deductible from the beginning of the income tax. And at that time, there were much fewer people home -- owning homes and very few people pay income tax. And that was true up until World War II. So this interest deduction really did virtually nothing until after the war when more people came into the tax system, more housing finance was available.

10:25:03

TODERAnd all of a sudden, it became an important subsidy. So now it's kind of an after-the-fact rationale. We look back and say, oh, it was put in there to encourage homeownership. No, it's really what we now say is a justification for keeping it. But I don't think it's a very good justification. If you look at other countries like England, as Seth mentioned, or Canada, Australia, they don't allow the deduction of mortgage interest than their homeownership rates, at least Canada, are as high as ours. So it just doesn't seem to be the case.

10:25:36

REHMWhat about that, Lawrence Yun?

10:25:38

YUNWell, in the case of England, one thing to be mindful of, as everyone knows, prices are determined by supply and demand. So removing the mortgage interest deduction certainly lowered the demand. But what happened in England was that they stopped producing housing. So housing start activity in England was much lower in proportionately compared to the U.S. So in England right now, many people are living in substandard housing.

10:26:04

YUNIn America, the housing standards are much higher. The builders are responding, building new homes. So one of the reasons why price is (word?) was just a supply restriction that occurred in England. But another thing I think we need to consider, as an economist, is that a thing that have something called positive externality. That is to say that it provides additional benefit in addition to, say, homeownership or buying a home. And this is related to many owner community where there is more civic involvement, more charitable giving.

10:26:36

YUNSo there tend to be more community spirit among owners versus the renters. And this positive externality flow into the community, the cities, and hence, the mortgage interest deduction is not only encouraging ownership, but also providing the positive externality. But I would also comment that we don't want to have unsustainable homeownership as we saw during the bubble year with easy credit, Wall Street going wild, Fannie and Freddie going wild. We don't want to see a repeat of that. But one cannot attribute to the recent bubbling crash to mortgage interest deduction.

10:27:09

REHMWhat about that positive externality, Seth?

10:27:13

HANLONI think there's -- it's a little unclear about the correlation and the causation. I think, certainly, communities that have large percentage of homeowners, you might see more stable, you know, more stable residents and people, you know, committed to the local public schools and stuff. But that could be for the same reason that they're buying homes is that they want to invest and stay in the community.

10:27:36

HANLONAnd then there's a further question of causation as to whether the mortgage interest deduction is contributing to the levels of homeownership. So -- but then the question is, you know, so even so -- even if there are these positive externalities from the mortgage interest deduction, why should we target them more strongly at some communities with people who have -- tend to have larger houses and higher incomes? Why would we give them a bigger benefit than in other communities?

10:28:07

REHMBut let me understand clearly. You are in favor of gradually phasing out this interest tax deduction.

10:28:20

HANLONWell, I'd just call it phasing down the deduction into a flat credit. So there still is a benefit, in essence, a tax subsidy for mortgage interest. But it's one that's less costly and uniformed for all -- for taxpayers in all tax brackets.

10:28:36

REHMWhat about that, Ed Pinto?

10:28:40

PINTOI believe the -- in terms of the externalities, with the size of the standard deduction today, $12,000 for a couple, $6,000 for individual, giving more interest rates are -- the kinds of homeownership that you're talking about promoting isn't being promoted today by the interest deduction because the amount of the interest deduction is well within the amount of the standard deduction.

10:29:06

PINTOSo making these changes would have no impact in terms of those externalities promoting them or not promoting them. Again, my research shows that they're actually negative externalities that are going on in the housing market...

10:29:19

REHMSuch as?

10:29:20

PINTO...due to FHA lending.

10:29:20

REHMAh, OK. I want to hear from our listeners. We've got many folks waiting on the phone. Let's hear about their own views. First to Raleigh, N.C. Good morning, Bill. You're on the air.

10:29:39

BILLThank you. I guess everyone is -- it's obvious that the tax system is used to provide all kinds of stimulus to different things, which is why it's so complicated. That's just the comment. My big question is it seems like this discussion is a little premature at this time. There is going to be a big tax overhaul next year. But I'm one of these people who's under the $250,000 limit, and Obama's promising us no tax increase.

10:30:07

BILLSo why are we even discussing eliminating deductions, particularly for those of us under $250,000? Yeah, go ahead and do the rich if you like, but if there's going to be no increase in taxes for us, why are we discussing this now?

10:30:22

REHMSeth Hanlon.

10:30:24

HANLONI think that's a good point. I mean, well, first of all, there's -- they are discussing deduction limits in the fiscal cliff negotiations. The one idea floated from the Republican side is to put some kind of dollar cap on deductions, and it's unclear whether that would apply throughout the income scale or just to people at the top. But that would certainly indirectly affect the mortgage interest deduction and other deductions.

10:30:49

HANLONAnd then looking forward for next year, and just in terms of what President Obama has proposed, he certainly wants those top two rates for people over $250,000 to revert to their 19th -- their higher 1990s levels. And he would also -- has a proposal to limit deductions, including the mortgage interest deduction, for people in the top two tax brackets and limit it to what somebody in the 28 percent bracket would get. So, in other words, the people over 250 would still get their mortgage interest deduction, but the value of it wouldn't exceed that value that people below 250 get.

10:31:26

REHMBut the point is everything right now is still on the table. I think Bill in Raleigh, N.C. is right in that we don't know what is coming, but we are talking about what would happen not only to homeowners, but to the economy as a whole if this mortgage interest deduction went away. Thanks for calling, Bill. Let's go to Pittsburgh, Pa. Good morning, Dan.

10:32:00

DANGood morning, Diane. Longtime listener.

10:32:02

REHMThanks.

10:32:03

DANDiane, I just want to say the earlier caller was talking about property price increases. I don't think this mortgage tax deduction was meant, you know, to allow prices to increase, you know, whether it's a small home or whether it's a penthouse 65 floors above the street. It was meant to give people a chance and opportunity to have, you know, some liquefiable asset in case they, you know, get into a financial disaster later on.

10:32:25

DANAnd it is, as a citizen taxpayer, I'm saying now, a $100 billion hit. Something has to be done to modify that. Maybe not, you know, completely get rid of it, but, you know, I don't want to be -- continue to subsidize ever-increasing property prices. That only helps the seller, the real estate people and the lenders. It doesn't help, you know, the population.

10:32:47

REHMAll right. What about that, Lawrence Yun?

10:32:50

YUNI think the intent was not to raise prices, but the prices naturally rose because of the capitalization impact where, again, that dividend, that flows to the homeowner, and the next buyer recognized that dividend, that they are willing to make additional bid on it. So if we were to start from, say, blank slate, start a new country, all fresh, perhaps mortgage interest deduction needs to be on the table.

10:33:13

YUNHowever, we have a history, 100-year history. People have already made their decision based on the mortgage interest deduction. They knew what the rules of the games were. So now if we were to change that rules, then you are essentially destroying the wealth that have accumulated over time.

10:33:28

REHMAnd you're listening to "The Diane Rehm Show." Do you want to add to that, Eric Toder?

10:33:37

TODERWell, just one small point. I think Lawrence is right that there is a price effect that may not be as large as what he says it is. But one of the aspects of the price effect is it helps price out lower-income people who can't use the deduction from buying homes. So it's not all a positive thing in terms of home ownership.

10:33:56

REHMAll right. Let's go now to Cleveland, Ohio, and to Bill. Good morning. You're on the air.

10:34:04

BILLGood morning, Diane. The comment I have to make is that there are so many citizens who are still underwater on their homes or on refinanceable to the lower interest rates. So they're still sitting with higher interest rates. To hit them up with a deduction and remove the deduction is just another slap in the face, and often in instances that tax saving may be the difference between them being and not being able to actually make their mortgage payments, perhaps putting and maintaining a maximum amount of deduction.

10:34:39

REHMWhat about that, Ed Pinto?

10:34:42

PINTOI think that sets up a false choice. I know of no one suggesting to do away with the interest deduction all at once, period. All of the suggestions are being made around saving it out over many years. But the biggest suggestion is about creating a cap on the amount of deductions overall, including state income tax deductions and property tax deductions and interest deductions. No one is suggesting that you just go cold turkey and do away with it. So to argue that's going to be a problem is a false argument.

10:35:17

REHMHowever, there is perhaps in the minds of people who have purchased houses this belief, which it's going to take a long time to get rid of, that part of the advantage of home ownership is that tax deduction. Here's a tweet, saying, "We simply cannot get rid of the mortgage interest deduction. This is the pillar of home ownership and crucial to the housing market." How do you respond to that, Seth?

10:35:56

HANLONWell, I think, you know, first of all, we're talking about changes to the mortgage interest deduction in the context of overall deficit reduction. And so, you know, we talk about people's expectations or their vested interests, and I think, you know, as Ed just mentioned, we need to take that into account and phase in any changes over time. But the problem of, you know, people's expectations is not limited just in the mortgage interest deduction.

10:36:23

HANLONYou know, people are -- the negotiators for the fiscal cliff are talking about changes to Social Security and Medicare, including, you know, possibly even raising the retirement ages on those programs. And, of course, you know, people are planning for their retirements, and they're planning, you know, thinking about their health care.

10:36:39

REHMSo everything is on the table.

10:36:42

HANLONExactly. And if everything is going to be on the table, I think we have to look at a program like the mortgage interest deduction. It has to be on the table too.

10:36:48

REHMWhat about that, Lawrence?

10:36:49

YUNWell, everything should be discussed because the recent rise in budget deficit, I mean, these are huge, unsustainable, and it can wreak havoc for the country's economy down the line at some point. So we need to address that.

10:37:03

YUNBut if we look at the trillion-dollar budget deficit that was the case last year or the past four years annually and some tweaks that Seth was mentioning, one is looking at possibly bringing in revenue, maybe 10 billion, regarding the mortgage interest deduction, income limitation at the top. So these are small change. It would not be the solver of the budget deficit just from mortgage interest deduction.

10:37:29

REHMEverybody says almost exactly the same thing. This won't fix the whole thing. Little changes make big solutions. Short break, right back.

10:40:05

REHMAnd as we talk about the possible phasing out of the mortgage interest deduction, we have pro and con emails here. The first from Rachel in Monroe, Wis., who says, "I just heard your guest state the home mortgage deduction cost the government. The U.S. government is supported by all of us, which means the renters and other non-homeowners are supporting homeownership for others. That is so unfair on its face. It's hard for me to understand why there is more protest about it from everyone who does not own a home."

10:40:58

REHMNow, here's different view from someone in New York, who says, "Your pro-removal guests are so way off. They need a reality check. They clearly do not understand the importance of this deduction for many people who, due to their present income ratio, will not benefit via tax credit instead of the deduction. The deduction makes owning the home affordable with lower interest rates now on savings and retirement funds." So there you have it, gentlemen. Go ahead, Lawrence.

10:41:44

YUNWe looked at the data on the federal income tax, and we found that about 85 percent or 90 percent of all federal income tax revenue are from homeowners. So homeowners are already bearing a sizeable portion of the tax revenue already. So removing the mortgage interest deduction would mean even a higher burden on the nation's homeowners.

10:42:08

REHMEd Pinto, do you want to comment?

10:42:13

PINTOWell, I think the point that was in the first email is a good one. You have about a third of individuals that are renters. Of the people who own homes, about 30 percent of them have no mortgage. So that gets you over 50 percent of individuals who either have no mortgage or rent and then of the people who do have a mortgage which is about 45 percent of the population, total population.

10:42:40

PINTOI'd say -- I don't have the numbers in front of me -- but I'd say a good two-thirds of them to 75 percent don't pick the deduction because they're within the standard deduction. So you actually have a very small percentage of people in the United States who actually benefit from this deduction. So that, I think, very persuasive, and then you have the issues of the distortions that create and picking winners and losers and things like that which is always a bad thing to do in the tax code.

10:43:08

PINTOAs to some of the comments about timing, the timing, the lobby that's in favor of keeping this deduction says no matter when it is that the timing is bad, if it's a boom time, it's bad. I was in one of the housing lobby offices the other day, and I saw an ad on the wall saying save the American dream, fight efforts to do this or that, in which they did 1986, the middle of one of the strongest booms in the country. There is never a time when the housing lobby's going to say now is a good time to do anything that they view as being detrimental to their interest.

10:43:45

REHMSeth.

10:43:46

HANLONYeah. And just to amplify something that the first email said, you know, the mortgage interest deduction we had mentioned was a -- it cost the government about $100 billion per year, and that's about double what the budget is for the Department of Housing and Urban Development every year. So it's -- the MID, mortgage interest deduction, is sort of, by far, our largest housing program.

10:44:06

HANLONAnd so I just think that's important because, again, in the context of deficit reductions, we're looking across the board at the government of where do you -- where to cut, where do I take a scalpel to, where we can get efficiencies. And so our -- basically, our largest housing program, which is actually an inefficient subsidy for housing for homeownership, should certainly be looked at.

10:44:28

REHMAll right. To St. Louis, Mo. Good morning, Peter.

10:44:32

PETERGood morning. Thank you for having me.

10:44:34

REHMSure.

10:44:35

PETERI'm a first-time caller, and I enjoy your show, Diane.

10:44:39

REHMThank you.

10:44:40

PETERAnd, you know, I've been living in the United States for almost eight years now, and I've been working hard. My family has been away from me. (unintelligible) join me this year, and I decided to buy a house and because I know, for the first time, I'm going to be getting a tax break. And this is actually the official tax deduction that I'm getting with the child tax credit.

10:44:55

PETERBefore I was just going to school and pay my tuition, so that I can deduct that from my taxes. That would be very disappointing if they have been pushing and the Congress will take that away from people like me. We just new here, and that's the big incentive that we have to buy a house.

10:45:30

REHMEric Toder, how do you respond to Peter?

10:45:35

TODERWell, I guess I would say in -- actually, people in Peter's position are probably people who are less hurt by this just simply 'cause the interest rates are so low today. And you have to look at this -- the government is running a big long-term fiscal deficit. It's going to have to be reduced over time, and some other thing is going to have to be done, either higher tax rates or, as Seth mentioned, cuts -- increases in the retirement age for Social Security or cuts in other programs.

10:46:10

TODERSo it is not free to allow this deduction, and everybody is going to be hurt by it in some way. The other thing I would say is the people who are probably hurt the most are people who have purchased the house fairly recently and have bought more house than they could afford without the deduction, as one of your callers mentioned earlier. And I do think we need to do something about those to help those people 'cause we have made that promise, but I think that's dealt with by phasing it out slowly in an intelligent way.

10:46:44

REHMHere's an email from Carol in Columbia on that very point, Eric. She says, "When I was about to buy my house, my uncle who is a builder himself said, if I could not afford it without that deduction, I was buying too much house. Are there times perhaps when people assume that because that tax deduction is there, they can perhaps afford to buy more house than they might otherwise?" Lawrence Yun.

10:47:25

YUNI would say that's a very good advice because people should stay well within their budget, leave a little room for margin of error just in case they lose job. So it's a good action to stay within the limit. But the mortgage interest deduction on top of that is providing additional monetary benefit for the home buyer. So I think that's good.

10:47:49

YUNAnd even though at any given year, the number of people who take mortgage interest deduction may not sound large, many people at some point in their life, you know, the homeowners, have taken the mortgage interest deductions. And primarily, it's the younger families who are primarily beneficiary of mortgage interest deduction because over time, they are paying off their mortgage, so they do not have to use the mortgage interest deduction. But in terms of the age distribution, it's primarily the younger couples who would be hit most from changes.

10:48:22

REHMAll right. To Bethesda, Md. Hi there, Greg.

10:48:27

10:48:33

REHMSure.

10:48:33

GREGI think your -- as your guest from the realtors association said, you're going to kill middle-class families. And I think one other point, whether you're in Bethesda, Md., the suburb of New Jersey, a suburb of Boston, a suburb of L.A., family making 250 or $300,000 or 200 to $300,000 with two kids and you're doing everything right, saving for college, paying life insurance, et cetera, you start phasing out your tax benefits. You're absolutely killing the middle class. And this is coming from a true blue Democrat. You can't -- it just -- you can't look at one side of the ledger.

10:49:08

REHMSeth Hanlon, do you want to comment?

10:49:10

HANLONSure. I mean, I think -- first of all, if you -- let's look at the president's plan. You know, he has this threshold of -- for income tax increases, it's at $250,000. But what means is that no one under those limits would pay a penny more. But then if you look at the people who are just above those thresholds, and The New York Times had an article about this looking at the numbers, those people would pay only slightly more if at all.

10:49:36

HANLONAnd so, I mean, when you look at the sort of magnitude of our fiscal challenges, we certainly need to make people pay who, you know, who make much more than that, 500 or more than a million to pay significantly more. But then after that, I think it's reasonable to expect people making $250,000 or among the, you know, top 2 percent of the population to pay slightly more.

10:49:58

REHMAll right. Here's a view from another perspective. This is from Richard in Ann Arbor, Mich., who says, "Until 1986, all interest, mortgage, car loans, credit card interests, personal loans was deductible. Second, corporations can deduct virtually all interests, even now. So it comes down, I think, to a lot of people's minds to a question of fairness. If, in fact, individuals lose at homeowner's mortgage interest rate deduction, how about corporations, are they going to lose some of their deductions?" What about that, Eric?

10:50:50

TODERWell, that's a complicated question. But the simple answer is for all businesses, interest that they pay is a cost of earning income. So you don't want to tax people on their cost of an earning income. You want to tax them on their net income. That's being used to generate revenue, which is taxable. So if you run a small business, you can deduct the interests you pay on your property. You can deduct the wages you pay to your employees. And that's perfectly reasonable because those payments are not part of your income.

10:51:24

TODERWe don't allow people to deduct interests they pay for consumption purchases 'cause that is a use of your income. And the only exception we make is for home mortgage interests. I say it's complicated because businesses don't get taxed on all of their income, and maybe you need to think of some limits on interest deductions for corporations. But the general principle is it's perfectly OK for businesses to deduct interest rates.

10:51:52

REHMWhat about that, Lawrence?

10:51:54

YUNIn talking about the distortion impact, well, let's look at the hypothetical, say, the mortgage interest deduction is eliminated. I don't think it will happen, but let's look at the hypothetical. You could have a investor, that is people buying a home to rent it out. They would be able to deduct their interest. So if a primary homeowner would be unable, while people who are investors, who are renting it out, would be able to deduct that interest.

10:52:18

YUNSo now one is creating a distortion about, well, do I buy home and then rent it out and find another family member to -- so, you know, they'll get tax benefit? So it can cause a huge new degree of chaos in the market.

10:52:30

REHMEric.

10:52:32

TODERLawrence is exactly wrong on that point. The renter -- the landlord is paying tax on the rental income. The homeowner is not paying tax on the value of the rental services that he is receiving from his home. So it is perfectly reasonable for interest to be deducted by the homeowner. And the renter is, in the prize of the rent, paying for the tax that the landlord is bearing.

10:53:00

REHMEric Toder of the Urban Institute, and you're listening to "The Diane Rehm Show." And let's go to Bradenton, Fla. Hi there, James. You're on the air.

10:53:15

JAMESThank you very much for taking the call. And I'm delighted with the discussion today. It's quite insightful. So I was in public accounting several years ago. And one of -- at that time, the average loan duration was some seven years on a first mortgage. And so that's my data point. And it may not be relevant any more.

10:53:38

JAMESBut if it is, if you take that, combined with the historically low interest rate and you look at the deduction that's generated by that, it would seem totally reasonable to phase out the mortgage deduction over seven years and be done with it, give people that have, you know, higher rate mortgages today, you know, some cover.

10:54:00

JAMESAnd basically for those that are lucky enough to get the 2.5 percent or whatever it is, the impact on the taxation is relatively minimal unless you buy a huge house. And somebody who talks about income in the Northeast, that the quarter of a million as being a heartache and a hardship strikes me as a little bit much. And I'd rather have our country return to some status of using good thinking about the deductions and economics than to perpetuate them, a benefit that really doesn't seem to benefit most people.

10:54:40

REHMAll right. Thanks for your call. Lawrence.

10:54:43

YUNOh, well, I mean, the data clearly shows that the -- that most homeowner, at some point in their life, has benefited from mortgage interest deduction because of the history of the nature, and it has been in place for 100 years. I should 99 years to be technically correct. And over this 99-year period of time, America went through many things -- Great Depression, a tremendous economic expansion, 1950, 1960s, the inflation. And then we had the Internet bubble.

10:55:10

YUNThrough all this process, ups and down, whether because of mortgage interest reduction or in spite of mortgage interest reduction, America has attained the economic supremacy over other countries. So some economists argue that the mortgage interest deduction is holding back economic growth. I would argue the other way, that homeownership provides incentive for people to work hard when thinking the long-term vision.

10:55:33

YUNThey have 30-year fixed rate mortgage, so they are not thinking the next week. They are thinking planning ahead, 10 years, 20 years, 30 years down the line. And that provides the motivation to work harder.

10:55:43

REHMEd Pinto, what's your best guess as to whether there will be some changes in the mortgage interest deduction as part of the fiscal cliff negotiations?

10:55:58

PINTOI believe that there is a good likelihood there'll be some changes whether they're part of the immediate fiscal cliff negotiation or next year's negotiation 'cause it's not clear where some of these things are going to fall. I do believe the idea of limiting deductions to a certain amount, this bucket concept, is one that has gained the fair amount of interest and support.

10:56:21

PINTOAnd I think it has a good likelihood of moving forward exactly. What the details are, no one knows. I don't expect at this point that there would be a phase out, a direct phase out of the interest reduction because that would just take on one facet. You have an easier time if you do the bucket limitation on deductions.

10:56:45

REHMSeth Hanlon, last word.

10:56:47

HANLONI agree. I mean, I think I would -- I'd rather have either a percentage limit on deductions or turn them into credits than a dollar cap. I just think it works better, but I would agree with Ed that this would be considered and by Congress next year probably.

10:57:02

REHMSeth Hanlon of the Center for American Progress, Ed Pinto of the American Enterprise Institute, Lawrence Yun of the National Association of Realtors and Eric Toder of the Urban Institute, very interesting discussion. Thank you, all.

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